Accepting Risk Flashcards
Risk appetite and risk efficient
Different stakeholders will have different risk appetites. It is important for an actuary to understand the client’s risk appetite
Risk appetite will also vary within a class of stakeholders, e.g. dependent on features of a particular individual or a particular company
Risk appetite may be related to:
• existing exposure to the risk
• the culture of the individual/company
Sufficient capital is needed if a risk is to be retained. Individuals rarely have sufficient capital to absorb the consequences of a risk event occurring
The fact that different stakeholders have different appetites for risk enables risks to be transferred between different entities in exchange for a monetary payment
Where there is a good market for risk transfer, the system is said to be risk efficient
Risk and product design
Insurance products are prime examples of a means by which one party transfers risk to another party, for a cash payment which needs to cover the cost of the risk plus profit
Collective investment schemes allow individuals to transfer the risk of making poor investment decisions due to lack of expertise or lack of time to perform research
All risks involved in a product should be identified during the product design process, and mitigation techniques considered. It may be possible to hedge risks across different product types (e.g. immediate annuities and whole life assurances)
There is a risk that a product design will not meet beneficiaries’ needs and desires. This can be addressed through market research and trials
Additional options may make a product more attractive, but also introduce new risks and therefore additional cost
In order to determine an appropriate cost for a particular policy, risks should be classified into subgroups, each of which represents a homogenous body of risk with a particular set of rating factors
Criteria that makes a risk insurable
A risk is insurable if:
• the policyholder has an interest in the risk
• the risk is of a financial and reasonably quantifiable nature
• the claim amount payable bears some relationship to the financial loss
Desirable criteria for a risk to be insurable
• individual risks should be independent
• the probability of the event occurring should be relatively small
• large numbers of similar risks should be pooled to reduce variance
• there should be a limit on ultimate liability undertaken
• moral hazard should be eliminated as far as possible
• there should be sufficient existing data/information in order to quantify risk
Pooling risk
Insurers and reinsurers take on risks in return for a premium because in doing so they can combine or pool many risks together
This means that the law of large numbers takes effect, which implies that actual results are increasingly likely to be close to expected results, which results in greater certainty (lower volatility) for the insurer
Through the assessment and control of risk, actuaries create opportunities for insurance companies to make profit by accepting risk
